Vernoia, Enterline + Brewer, CPA LLC

Archive for April, 2015

The IRS has announced that it will disallow claims for refunds of Federal Insurance Contributions Act (FICA) taxes paid with respect to most severance payments and will take no further action on any of the appeal requests from denied FICA tax refund claims that it suspended pending the resolution of the Quality Stores case. The IRS restated the holding of Rev. Rul. 90-72, in which it determined that supplemental unemployment benefits (SUB) payments were wages for FICA tax purposes except for payments falling under a narrow exception: SUB payments to terminated employees must be linked to the receipt of state unemployment benefits and not paid in lump sum. The IRS’s action follows the U.S. Supreme Court’s 2014 decision in Quality Stores, 2014-1 ustc ¶50,228.

Background

Quality Stores involved an employer that made severance payments to several hundred of its employees who had been terminated while the company was in Chapter 11 bankruptcy. The government withheld FICA tax from the payments, and the company sought a refund on its behalf and on behalf of its former employees.

Initially, the Sixth Circuit Court of Appeals held that the severance payments were not wages for FICA tax purposes. This created a Circuit split because the Sixth Circuit’s decision contradicted the Federal Circuit’s 2008 ruling in CSX Corp., 2008-1 ustc ¶50,218 that severance payments were wages for FICA and tax purposes.

Ultimately, the U.S. Supreme Court reversed the Sixth Circuit. It held that FICA defines wages as all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash. The Court found that the term “employment” encompasses any service, of whatever nature, performed . . . by an employee for the person employing him. Severance payments, the Court held, are therefore remuneration. Severance payments are made to employees only. It would be contrary to common usage to describe as a severance payment, remuneration provided to someone who has not worked for the employer, the Court observed.

Claims
The IRS reported that before the Supreme Court’s decision in Quality Stores, it had received FICA refund claims (along with claims for refunds of Federal Unemployment Tax Act (FUTA) and Railroad Retirement taxes (RRTA) paid with respect to severance payments). After the IRS disallowed these claims, many taxpayers appealed to IRS Appeals. Action on these appeals was also suspended pending the Supreme Court’s decision in Quality Stores.

As a result of the Supreme Court’s holding in Quality Stores, the IRS stated in Announcement 2015-8 that it will disallow all claims for refund of FICA or RRTA taxes paid with respect to severance payments that do not satisfy the narrow exclusion in Rev. Rul. 90-72. The IRS will also disallow all claims for FUTA tax refunds. This treatment, the IRS explained, applies to all pending refund claims before the IRS. No further action will be taken on these claims, the IRS reported.

Rev. Rul. 90-72

In Rev. Rul. 90-72, the IRS provided one narrow exception under which SUB payments were not wages for FICA tax purposes by laying out specific factual circumstances under which SUB payments would qualify for the exemption. In summary, the exception states that to be excluded from the definition of wages for FICA purposes, SUB payments must be linked to the receipt of state unemployment compensation and must not be paid to the employee in a lump sum. The IRS clarified in Announcement 2015-8 that the exception in Rev. Rul. 90-72 continues to be in effect.

The U.S. Treasury Department has announced relief for individuals who may have received overpayments of the Code Sec. 36B premium assistance tax credit based on incorrect information from the Health Insurance Marketplace. Affected taxpayers will not need to refund any overpayment, the Treasury Department explained.

Form 1095-A

The Affordable Care Act generally requires individuals to have minimum essential health insurance coverage or make a shared responsibility payment, unless exempt. All individuals who enrolled in minimum essential coverage through the Health Insurance Marketplace for 2014 received Form 1095-A, Health Insurance Marketplace Statement, describing their coverage and the amount, if any, of advance payments of the Code Sec. 36B premium assistance tax credit. Only individuals who obtain health insurance through the Health Insurance Marketplace may claim, if eligible, the Code Sec. 36B premium assistance tax credit.

Incorrect forms

The Code Sec. 36 premium assistance tax credit for the entire year is computed based in part on an individual’s monthly premium for the applicable second lowest cost silver plan (SLCSP). In February, the U.S. Department of Health and Human Services (HHS) reported that it had issued some 800,000 incorrect Forms 1095-A. The incorrect forms referenced Marketplace benchmark plans for 2015 rather than 2014. The incorrect forms accounted for approximately 20 percent of taxpayers who received insurance through the Health Insurance Marketplace, according to HHS. The Marketplace has been contacting affected individuals, who will receive corrected Forms 1095-A.

Relief

If the taxpayer has already filed a return for 2014 and received a higher Code Sec. 36B premium assistance tax credit as a result of the error, the taxpayer may keep it, the Treasury Department explained. The IRS will not pursue collection action against that taxpayer. If, due to the error, a taxpayer who has already filed a 2014 return received a lower credit than he or she was entitled to receive, the individual may amend the tax return, the Treasury Department added.

The IRS will provide transition relief for Achieving a Better Life Experience (ABLE) accounts authorized by Code Sec. 529A of the Tax Increase Prevention Act of 2014. Although the IRS is supposed to issue regulations or other guidance on the accounts by June 19, 2015, the IRS recognized that many states are proceeding with enabling legislation and that taxpayers may set up accounts before the IRS issues guidance. The IRS does not want the lack of guidance in early 2015 to discourage the creation of ABLE accounts.

In Notice 2015-18, the IRS assured states authorizing an ABLE program, and individuals establishing accounts in accordance with state law, that the accounts will qualify under Code Sec. 529A even if they do not “fully comport with the guidance when it is issued.” The IRS also pledged to provide sufficient time for making changes to satisfy the guidance.

ABLE Accounts

ABLE accounts are tax-favored accounts maintained for beneficiaries who are blind or disabled. Contributions are not deductible but will accrue income tax-free in the account. Distributions will be tax-free if used to pay qualified expenses for the disabled beneficiary. These are expenses related to the eligible individual’s blindness or disability that are made for the benefit of the individual, including education, housing, transportation, employment, technology and personal support services, health, and other expenses.

Requirements

The accounts are similar to qualified tuition programs (QTPs) under Code Sec. 529, but are not identical. For example, contributions to a QTP are unlimited, while contributions per person to an ABLE account are limited to the annual gift tax exclusion ($14,000 for 2015). The beneficiary must establish and own the account. The beneficiary must be a resident of the state authorizing the program or of a contracting state that provides access to another state’s ABLE program. Unlike QTPs, only one ABLE account can be established per beneficiary.

The disability must have occurred before the beneficiary reached age 26. The beneficiary must be entitled to Social Security Act benefits, or must provide a disability certificate in accordance with IRS requirements, to be set out in the guidance. Amounts in the account below $100,000 cannot be included to determine the individual’s eligibility for federal means-tested programs.

The New Jersey Division of Taxation has issued guidance concerning the treatment of virtual currency, such as bitcoin and other cryptocurrencies for purposes of corporation business, gross income (personal), and sales and use taxes.

When a customer uses convertible virtual currency to pay for property, the sale is treated as a barter transaction. As a result, if a seller uses convertible virtual currency as consideration for goods or services, sales tax is due based on the amount allowed in exchange for the virtual currency. If the customer that provides convertible virtual currency in the trade receives property that is subject to tax, the customer owes tax based on the market value of the virtual currency at the time of the transaction, converted to U.S. dollars.

For purposes of corporation business tax and gross income tax, a taxpayer will realize gain or loss on the sale or exchange of convertible virtual currency. The fair market value of convertible virtual currency paid as wages is subject to New Jersey gross income tax withholding. The fair market value of convertible virtual currency received for services performed by an independent contractor must be measured in U.S. dollars on the date the contractor receives it. Finally, a payment made using convertible virtual currency is subject to information reporting requirements to the same extent as any other payment made in property. Technical Advisory Memorandum TAM-2015-1, New Jersey Division of Taxation, March 10, 2015

An employer must withhold income taxes from compensation paid to common-law employees (but not from compensation paid to independent contractors). The amount withheld from an employee’s wages is determined in part by the number of withholding exemptions and allowances the employee claims. Note that although the Tax Code and regulations distinguish between “withholding exemptions” and “withholding allowances,” the terms are interchangeable. The amount of reduction attributable to one withholding allowance is the same as that attributable to one withholding exemption. Form W-4 and most informal IRS publications refer to both as withholding allowances, probably to avoid confusion with the complete exemption from withholding for employees with no tax liability.

An employee may change the number of withholding exemptions and/or allowances she claims on Form W-4, Employee’s Withholding Allowance Certificate. It is generally advisable for an employee to change his or her withholding so that it matches his or her projected federal tax liability as closely as possible. If an employer overwithholds through Form W-4 instructions, then the employee has essentially provided the IRS with an interest-free loan. If, on the other hand, the employer underwithholds, the employee could be liable for a large income tax bill at the end of the year, as well as interest and potential penalties.

How allowances affect withholding

For each exemption or allowance claimed, an amount equal to one personal exemption, prorated to the payroll period, is subtracted from the total amount of wages paid. This reduced amount, rather than the total wage amount, is subject to withholding. In other words, the personal exemption amount is $4,000 for 2015, meaning the prorated exemption amount for an employee receiving a biweekly paycheck is $153.85 ($4,000 divided by 26 paychecks per year) for 2015.

In addition, if an employee’s expected income when offset by deductions and credits is low enough so that the employee will not have any income tax liability for the year, the employee may be able to claim a complete exemption from withholding.

Changing the amount withheld

Taxpayers may change the number of withholding allowances they claim based on their estimated and anticipated deductions, credits, and losses for the year. For example, an employee who anticipates claiming a large number of itemized deductions and tax credits may wish to claim additional withholding allowances if the current number of withholding exemptions he is currently claiming for the year is too low and would result in overwithholding.

Withholding allowances are claimed on Form W-4, Employee’s Withholding Allowance Certificate, with the withholding exemptions. An employer should have a Form W-4 on file for each employee. New employees generally must complete Form W-4 for their employer. Existing employees may update that Form W-4 at any time during the year, and should be encouraged to do so as early as possible in 2015 if they either owed significant taxes or received a large refund when filing their 2014 tax return.

The IRS provides an IRS Withholding Calculator at http://www.irs.gov/individuals that can help individuals to determine how many withholding allowances to claim on their Forms-W-4. In the alternative, employees can use the worksheets and tables that accompany the Form W-4 to compute the appropriate number of allowances.

Employers should note that a Form W-4 remains in effect until an employee provides a new one. If an employee does update her Form W-4, the employer should not adjust withholding for pay periods before the effective date of the new form. If an employee provides the employer with a Form W-4 that replaces an existing Form W-4, the employer should begin to withhold in accordance with the new Form W-4 no later than the start of the first payroll period ending on or after the 30th day from the date on which the employer received the replacement Form W-4.

There are three main types of IRS audits: correspondence audits, office audits, and field audits (listed in order of increasing invasiveness). Correspondence audits are initiated (and generally conducted) by postal mail. Office audits require a taxpayer and/or its representative to appear in an IRS office; and a field audit involves IRS examiners paying a visit to the taxpayer’s place of business.

Correspondence audits

Correspondence audits, as the name suggests, are conducted entirely through the U.S. mail. (The IRS never uses e-mail to correspond with taxpayers.) Correspondence examinations require less involvement from IRS examiners and are therefore used more frequently by the budget-strapped IRS. Because correspondence examinations make up such a large percentage of the total examinations the IRS conducts, they are considered the “work horse” of the IRS audit tools.

The IRS routinely uses correspondence examinations for issues that it generally deems more efficient and less burdensome to handle by mail, for example questionable claims for earned income tax credits (EITCs) or inconsistent line items.

Office audits

Generally, office examinations involve small businesses or individual income tax returns that predominantly include sole proprietorships. They involve issues that are too complex for a correspondence audit, which involves only the exchange of mail and (sometimes) a few telephone calls. Issues subject to an office audit, however, are usually not complex enough to warrant a full-scale field audit examination. Common issues include the substantiation of a business purpose, travel and entertainment expenses, Schedule C items, or certain itemized deductions.

In addition, if a taxpayer previously selected for a correspondence audit requests an interview to discuss the IRS’s proposed adjustments, the case may be moved to the taxpayer’s district office. Conversely, an examiner may sometimes determine that a tax return selected for an office audit examination would be better handled through a correspondence audit.

Office examinations generally take place at the IRS office located nearest to where taxpayer maintains its financial books and records, which is generally its residence or place of business. However, on a case-by-case basis the IRS will consider written requests from taxpayers or their representatives to change the office examination location. A request by a taxpayer to transfer the place of an office examination will generally be granted if the current residence of the taxpayer or the location of the taxpayer’s books, records, and source documents is closer to a different IRS office than the one originally designated for the examination. Additionally, Treasury Reg. 301.7605-1(e)(1) directs the IRS to consider several factors including whether the selected office audit location would cause undue inconvenience to the taxpayer.

Field audits

The IRS initiates a field exam audit usually by sending either a letter that lays out the issues to be examined and lists a specific IRS agent as the point of contact. Taxpayers must contact the revenue agent within 10 days of receiving the initial contact letter in order to schedule an interview. Generally an Information Document Request (IDR) also accompanies the initial contact letter and contains the IRS examiner’s description of the audit-related documents it wants to review.

Conducting a field examination of a tax return requires the agent to have far greater knowledge of tax law and accounting principles than do correspondence or office audits, and therefore, field examiners are generally much more experienced than other examiners. Field audits almost always take place where the taxpayer’s books, records, and other relevant data are maintained, which generally means the taxpayer’s residence or place of business. However, if a business is so small that a field examination would essentially require the taxpayer to close the business or would unduly disrupt the operation of the business, the IRS examiner can conduct the field examination at the closest IRS office or at the office of the taxpayer’s representative.

IRS officials, including Faris Fink, then Commissioner of the Small Business and Self-Employed Division, announced in 2013 that the IRS would increase its scrutiny of partnership entities. Indeed, the IRS’s audit statistics for 2014 have shown that Fink’s prediction was accurate. While the overall audit rate for all types of businesses fell from 0.61 percent in Fiscal Year (FY) 2013 to 0.57 percent for FY 2014, the audit rate for partnerships has increased.

The IRS’s recently released Winter 2015 Statistics of Income Bulletin underscores why IRS officials are becoming increasingly concerned about partnerships. The bulletin-which highlights several trends including partnership numbers-shows that the number of partnerships has been growing recently by 3.1 percent, year over year. Not only this, but the number of partners, the level of assets, and the total gross receipts received during this period all increased.

Passthrough entities like limited partnerships and limited liability companies (LLCs) have become an increasingly popular way of organizing businesses. (The IRS reported that domestic limited liability companies (LLCs) made up 65.3 percent of all partnerships.) Domestic limited partnerships-although representing only 12 percent of all partnerships-but reported 33.4 percent of all partnership profits (the largest figure of all types of partnership entities and the largest share of partners.

While incorporation was once the only means of shielding individual directors and officers from individual liability for the corporation’s obligations, passthrough entities can now be structured in such a way as to protect the individual partners from liability for the company’s debts. In addition, passthrough entities like partnerships can still enjoy the benefits of passthrough taxation. Corporations, on the other hand, are generally taxed twice: once at the entity level, and again when profits are distributed to the individual shareholders. S corporations are the exception there, being taxed only once at the owner/shareholder level and sharing many similarities with partnerships.

Partnership Statistics

The IRS’s Winter Statistics of Income Bulletin reported that the number of partnerships filing tax returns grew 3.1 percent (from 3,285,177 to 3,388,561) between 2011 and 2012. Since 2003, the number of partnerships has grown at an average annual rate of 3.9 percent. The Bulletin also reported that the number of partners has grown during each of the last nine years, increasing 3.9 percent (from 24,389,807 to 25,333,616) between 2011 and 2012. Partnerships with fewer than three partners made up more than half (55.9 percent) of all partnerships, the IRS reported. Partnerships with 100 or more partners, however, accounted for almost half (47.3 percent) of all partners in 2012.

For 2012, partnerships passed through $1,400.8 billion in total income minus total deductions available for allocation to their partners, the Bulletin reported. This amount represents a 43.4-percent increase from 2011 when partnerships passed through $976.9 billion. In contrast with Tax Year 2011, when individual partners received the largest portion of passthrough income, partners classified as partnerships received the largest portion of this income for 2012.

Need for Partnership Audit Reform

Tax administrators, including IRS Commissioner John Koskinen, have expressed concern that this growth in more profitable, more complex partnerships has created a dire need for reform of the current rules for auditing partnerships. The rules, they say, were legislated before partnerships became so complex, administrators say, and now the obstacles to the IRS’s efficient oversight of large partnerships in particular leaves room for a large tax compliance gap. For example, a report issued in September 2014 by the Government Accountability Office (GAO) revealed that the IRS’s field audit rate of large partnerships-defined by the GAO as having $100 million or more in assets and 100 or more direct and indirect partners-was less than one percent for FY 2012.

Several lawmakers, including President Obama, Rep. Dave Camp, R-Mich., and Sen. Carl Levin, D-Mich., have issued tax reform proposals that include changes for audits of partnership entities, but most of these have fallen flat in the debating room. Thus, the IRS is doing what it can without Congressional help, IRS officials stated during a recent tax law conference in Washington, D.C. Nancy Knapp, Associate Area Counsel, IRS Large Business & International Division (LB&I), stated that the IRS planned to increase audits of passthrough entities in the future. This increased focus, she said, stemmed from the IRS’s recognition that an estimated 191,000 of 296,000 L&I taxpayers are passthrough entities that generate revenue the IRS has up until now practically ignored.

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Disclaimer

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. If desired, Vernoia, Enterline + Brewer would be pleased to perform the requisite research and provide you with a detailed written analysis. Such an engagement may be the subject of a separate engagement letter that would define the scope and limits of the desired consultation services.
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